Richard C. Longworth, senior fellow at The Chicago Council on Global Affairs, contributes his knowledge and ideas about issues that affect the Midwest.

Wednesday, October 17, 2012

The Cost of Decline

(This is the third in a series of posts on globalization and American decline.)

American decline, increasingly obvious across the nation's landscape, remains controversial. Is the United States declining absolutely, as the Roman Empire did? Is it only declining relatively -- that is, it's strong but other countries are catching up? Is this decline only temporary, something that will disappear when the recession ends and we get our mojo back?

These are important questions. The recession certainly will end. No country can remain the sole superpower forever. So will everything be OK, so long as we keep America strong and vital?

The truth is that American decline is neither temporary nor relative. It doesn't have anything to do with the recession and not much to do with China. Yes, the recession will end and China could collapse, as some pundits predict. Neither will affect the reality of American decline.

This decline can be measured in two basic ways. Both are happening now. There is no sign that either will be reversed.

First is the decline in the nation's ability to create a structure of economic decency, to enable the majority of its people to enjoy a decent standard of living.

Second is the decline in the nation's ability to project power. Being a superpower is expensive. More than any other nation, America has had the means -- military, diplomatic, economic, cultural -- to get its way abroad. The world still looks to America for leadership, but this is a leadership we can no longer afford.

Examples at home? Have a look at official statistics showing decades of stagnating or falling median wages and household incomes, the growing number of children living in poverty, the loss of the kind of manufacturing jobs that supported Americans through most of the nation's history, especially the growing gap between the super-rich and the rest.

If the only true purpose of an economy is the well-being of the people who live within it, the American economy is declining.

Examples abroad? Two unfunded wars in Afghanistan and Iraq have led to most of the fiscal deficit and, as the most recent Chicago Council on Global Affairs poll showed, to declining public support for an active foreign policy. Globalization itself has tied our hands in many areas. The U.S., for example, is still committed to defending Taiwan against a China that could bankrupt us with the flick of a mouse. Obviously, it's a commitment we'll never keep.

For all our flag-waving and our Vietnam-sized mistakes, American power has been the key to global stability for sixty years. A world that often resented American strength should fear American weakness.

Earlier posts have described the role of globalization in this decline. Global markets have led to the wave of outsourcing that eliminated many of the jobs, skilled and semi-skilled, that employed much of America's middle class. Lower wages abroad have forced down wages here, or have led to job-killing automation. Especially, as the economy goes global, so do the people -- financiers, CEOs -- who run that economy. Many still carry American passports, but their priorities are global. No longer dependent on the American, they have literally lost interest in American society and feel no responsibility to it.

Americans are taught that a free market economy creates a healthy society. It's important to note that the global market now is actually working the way a market should work. As Michael Spence, the Nobel Prize-winning economist wrote in Foreign Affairs:

"Faced with an undesirable economic outcome, economists tend to assume that its cause is a market failure....But the effects on the U.S. economy of the global economy's structural evolution is not a market failure: it is not an economically inefficient outcome. (If anything, the global economy is generally becoming more efficient.) But it is nonetheless a cause for concern in that it is creating a distributional problem in the advanced economies."

For a classical economist, this is heresy. Spence is saying that globalization enables capital to be invested where it can be most efficiently used -- that is, where it produces maximum profit. Theoretically, this investment, plus free trade, should raise the overall economy. In fact, this is happening: the global economy is definitely growing. But as Spence said, it's producing "distributional problems," which means it's creating winners and losers. The losers happen to be in "advanced economies." In other words, here.

If Adam Smith wrote the rules for a market economy, American economists -- especially at the University of Chicago -- refined them. If markets are good, American-style free markets are better: so this thinking went. Mixed economies, as in Europe, are "rigid" and semi-capitalist economies with heavy state ownership, as in China, couldn't possibly work.

This theory was easy to promote so long as the American economy demonstrably out-performed the rest of the world. It's harder now that this economy has stopped performing for the majority of Americans.

Robert Gordon, the Northwestern University economist, has written that there have been three bursts of innovation, two of which led to long periods of economic growth. The first (1750 to 1830) gave us steam engines and railroads and created the Industrial Revolution. The second (1870-1900) gave us electricity, communications, chemicals and the like, and produced the immense expansion of the 20th century.

The third, starting in 1960, gave us computers, the web and space-age communications. This has indeed led to growth, both absolute and per capita, in former Third World countries. But it had "a damaging effect on the nation with the highest wage level, i.e., the United States."

The American winners are corporate CEOs who can operate globally, Gordon has written. The losers "are those not only whose jobs are lost to imports and outsourcing, but those whose incomes are beaten down as foreign investment flocks to southern states with lower wages, and as corporations like Caterpillar are successful in extracting concessions on wages and benefits from their employees."

There are three things to note here. First, this is an epochal shift in the economy, ending 250 years of Western growth: Gordon doesn't even mention the current recession. Second, China plays a role as the destination of jobs but, if China collapses tomorrow, the process would go on, since it's based on technology that isn't going to disappear.

Third, there's no reason to think things will go back to the good old days.

Some economists dispute Gordon, arguing that innovation will come to the rescue. But this sounds like wishful thinking: no one knows where this innovation will arise. And even if it does, there's no reason to think that it will alight here or change the structure of inequality that bedevils the nation: the latest wave of innovation that Gordon cites has only made this inequality worse.

No wonder the subject of American decline has not even been mentioned in the presidential election campaign. No candidate ever won votes by talking about American weakness. And both candidates know perfectly well that, powerful though the office may be, no American president has the power to reverse what is a permanent decline rooted in a global tide that rises far from American shores.

4 Comments

I'm not so sure our ability to project power will be that hugely affected. The US only spends 4.7% of GDP on the military according to the World Bank. That's not particularly high by historical standards. I've read that the cost of Iraq + Afghanistan was incrementally a trillion dollars or so. Not to excuse misadventures, but that's less than just this year's deficit. Our fiscal issues certainly have implications for the military, but out of control spending on military matters is not the driver of deficits. The leading drivers of increased deficits are unfunded entitlements that represent an income transfer to current and near retirees from younger and future generations. Also the related matter of our healthcare costs being too high by developed world standards, which would seem fixable (even if just by adopting someone another country's more cost effective system) even if the Affordable Care Act actually raises prices. On a normalized near term basis, the biggest driver of the deficit is the national debt itself. The amount we pay annually in interest is basically equal to the entire deficit as of 2007. In other words, we could have been in balanced budget territory if we didn't have all this debt! That by itself helps illustrate the pernicious nature of our current fiscal path.

By avoiding wars, cutting back on the most egregious corporate welfare, some entitlement changes, healthcare cost fixes, and tax reform (which could include increases on high income earners), we should have no trouble financing our military and any necessary uses of it.

As for China, they can't "bankrupt" us as a threat over Taiwan. If war broke out over it and we won, imagine what would happen to China if we decided to repudiate our debt to them as a form of reparations. It's like the old saying, if you own a billion dollars the bank has a problem. China's economy is arguably more dependent on ours than we are on them. If we go broke, they've got big problems on their hands.

I'd refine Aaron's remarks to more precisely point out that it is healthcare entitlements driving the huge structural deficit.

Growth in the healthcare entitlements is driven by four factors: healthcare service and drug prices increase faster than other prices in the economy; increasing lifespans (partly due to advanced medicine) mean that people will collect Medicare longer than in past decades; aging of the very large Baby Boomer cohort (1946-64 births); and general health of the population is declining (partly from old age but mostly from increasing levels of obesity and its related diseases and conditions).

Oddly, when Congress raised the Social Security retirement age for Boomers in the last "fix", it did not also change the Medicare program.

I've read this series with interest. I don't see where you mention America's post-WWII position as "last man standing", which in my opinion made us rich, i.e. much of the world had to come to us to buy stuff to rebuild themselves, and we profited. Prior to WWII, we were mired in a decade long Depression, and prior to that there was no safety net, no environmental protections, no OSHA, no FDIC, no EEOC, etc etc. All that stuff is expensive too. And people live longer now. Very few want to go back to that time either, so we're stuck with the costs, which means we aren't going to be the low cost producer of much of anything.

And of course the world doesn't have to come to us for a whole bunch of manufactured stuff anymore, and hasn't for some time. The midwestern industrial base started to creak in the 1970's after the western industrialized world had largely rebuilt itself, and has been going down hill since, with occasional little upticks. American companies were "able" to give their workers more benefits back then because they could pass the costs on to others - why have labor strife under those conditions? Just pay the workers off. They haven't been able to do that since the '70's really.

But this seems to me to explain much of the problem - we got too rich off WWII, and people have come to think of that post war era as 'normal'. It was probably the most abnormal period in our economic history, and is unrepeatable. If there's a WWIII, we will get hit.

So the point here is, yes, we are dependent on high value-added goods and services for the near term future (eventually, China and other developing nations will have to implement their own versions of EPA, OSHA, etc, but I'd say it's a ways off). And our workers need to understand that. They need skills and they have to want to acquire them (i.e. they need to be motivated).

You've written some on redesigning the Big Ten universities and using local community colleges as skill builders. I think these kind of ideas hold a lot of promise for "regular" workers, especially the community college bit. Perhaps you could expand on these ideas.

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